1. Externalities - Definition and examples An externality arises when a firm or person engages in an activity that affects the wellbeing of a third party, yet neither pays nor receives any compensation for that effect. If the impact on the third party is adverse, it is called a externality. The following graph shows the demand and supply curves for a good with this type of externality. The dashed drop lines on the graph reflect the market equilibrium price and quantity for this good. Adjust one or both of the curves to reflect the presence of the externality. If the social cost of producing the good is not equal to the private cost, then you should drag the supply curve to reflect the social costs of producing the good; similarly, if the social value of producing the good is not equal to the private value, then you should drag the demand curve to reflect the social value of consuming the good.O Supply Demand O Supply PRICE (Dollars per unit) Demand QUANTITY (Units)With this type of externality, in the absence of government intervention, the market equilibrium quantity produced will be than the socially optimal quantity. Which of the following generate the type of externality previously described? Check all that apply. The city where you live has granted a permit to put a movie theater in your neighborhood, causing traffic jams at night and on weekends. Kyoko has planted hundreds of flowers in her front yard, beautifying the neighborhood both for herself and for her neighbors. A leading software company has decided to increase its research budget for inventing new open-source technologies. Your roommate Rina has bought a puppy that barks all day while you are trying to study economics.2. Efficiency in the presence of externalities Trucks impose many external costs on society: heavy air and noise pollution, traffic safety issues and road congestion, and so on. Therefore, the market equilibrium quantity of diesel trucks does not equal the socially optimal quantity. The following graph plots the demand for diesel trucks (their private value), the supply of diesel trucks (the private cost of producing them), and the social cost of diesel trucks, including both the private cost and external costs. Use the black point (plus symbol) to indicate the market equilibrium quantity. Next, use the purple point (diamond symbol) to indicate the socially optimal quantity.Social Cost Market Equilibrium Supply (Private Cost) Socially Optimal Level PRICE OF DIESEL TRUCKS Demand (Private Value) QUANTITY OF DIESEL TRUCKS3. The effect of negative externalities on the optimal quantityof consumption Consider the market for electric cars. Suppose that a electric car manufacturing facility dumps sludge into a nearby river, creating a negative externality for those living downstream from the facility. Producing additional electric cars imposes a constant per-unit external cost of $400. The following graph shows the demand (private value) curve and the supply (private cost) curve for electric cars. Use the purple points (diamond symbol) to plot the social cost curve when the external cost is $400 per unit.2000 1800 Social Cost 1600 O 1400 O 1200 O Supply (Private Cost) 1000 PRICE (Dollars per unit of electric cars) 800 O Demand 600 (Private Value) 400 200 0 0 1 2 3 4 5 6 7 QUANTITY (Units of electric cars)The market equilibrium quantity is _ units of electric cars, but the socially optimal quantity of electric car production is units. To create an incentive for the firm to produce the socially optimal quantity of electric cars, the government could impose a of $ per unit of electric cars.1.5 2 2.5 3 3.5 4 4.5 5 5.51.5 2.5 3 3.5 4 4.5 5.54. Understanding different policy options to correct for negativeexternalities Carbon dioxide emissions have been linked to degradation of air quality. The following table lists some potential regulations targeting the amount of airborne carbon dioxide. For each policy listed, identify whether it is a command-and-control policy (regulation), tradable permit system, corrective subsidy, or corrective tax.Tradable Command-and- Permit Corrective Corrective Public Policy Control Policy System Subsidy Tax The government orders every factory to adopt a new technology, which O O O O reduces carbon-dioxide emissions into the atmosphere. The government charges factories $500 for every ton of carbon dioxide O O O they emit. O The government limits total carbon-dioxide emissions by all factories to 250,000 tons per year. Each individual factory is given the right to emit O O O O 280 tons of carbon dioxide, and factories may buy and sell these rights in a marketplace. Trees take carbon dioxide out of the air and convert it to oxygen, so the government funds a tree-planting initiative by offering $500 to any citizen O O O O who plants a tree.5. Correcting for negative externalities - Regulation versus tradablepermits Suppose a municipality votes to reduce the combined pollution introduced by three local companies. Presently, each firm creates 4 units of pollution in the area, for a total of 12 pollution units. The government can reduce total pollution in the area to 6 units by choosing between the following two methods: Methods to Reduce Pollution 1. The government imposes pollution standards using regulation. 2. The government issues tradable pollution permits. The costs faced by each firm are different, so it is more difficult for some firms to reduce pollution than others. The following table shows the cost faced by each firm to eliminate each unit of pollution. Assume that the cost of eliminating all 4 units of pollution (that is, reducing pollution to zero) is prohibitively expensive for all three firms.Cost of Eliminating the... First Unit of Pollution Second Unit of Pollution Third Unit of Pollution Firm (Dollars) (Dollars) (Dollars) Firm A 130 165 220 Firm B 600 750 1,200 Firm C 90 115 140 Next, suppose that two government officials proposed alternative plans that would reduce pollution by 6 units. Method 1: Regulation The first government employee suggests reducing pollution through regulation. To meet the pollution goal, the government requires each firm to reduce its pollution by 2 units.Complete the following table with the total cost to each firm of reducing its pollution by 2 units. Total Cost of Eliminating Two Units of Pollution Firm (Dollars) Firm A Firm B Firm C Method 2: Tradable Permits Meanwhile, the other employee proposes using a different strategy to achieve the government's goal of reducing pollution in the area from 12 units to 6 units. This employee suggests that the government issue two pollution permits to each firm. For each permit a firm has in its possession, it can emit 1 unit of pollution. Firms are free to trade pollution permits with one another (that is, buy and sell them) as long as both firms can agree on a price. For example, if firm A agrees to sell a permit to firm B at an agreed-upon price, then firm B would end up with three permits and would need to reduce its pollution by only 1 unit while firm A would end up with only one permit and would have to reduce its pollution by 3 units. Assume the negotiation and exchange of permits are costless. Because firm B has high pollution-reduction costs, it thinks it might be better off buying a permit from firm C and a permit from firm A so that it doesn't have to reduce its own pollution emissions. At which of the following prices is firm C willing to sell one of its permits to firm B, but firm A is not? Check all that apply.O $118 O $141 $183 O $650 O $670 Suppose the the government has set the trading price of a permit at $454 per permit.Complete the following table with the action each firm will take at this permit price, the amount of pollution each firm will eliminate, and the amount it costs each firm to reduce pollution to the necessary level. If a firm is willing to buy two permits, assume that it buys one permit from each of the other firms. (Hint: Do not include the prices paid for permits in the cost of reducing pollution.) Initial Pollution Permit Final Amount of Pollution Cost of Pollution Allocation Eliminated Reduction Firm (Units of pollution) Action (Units of pollution) (Dollars) Firm A 2 Firm B 2 Firm C 2 Regulation Versus Tradable PermitsDetermine the total cost of eliminating six units of pollution using both methods, and enter the amounts in the following table. (Hint: You might need to get information from previous tasks to complete this table. ) Total Cost of Eliminating Six Units of Pollution Proposed Method (Dollars) Regulation Tradable Permits In this case, you can conclude that eliminating pollution is V costly to society when the government distributes tradable permits than when it regulates each firm to eliminate a certain amount of pollution.Buy one permit Buy two permits Don't buy/sell Sell one permit Sell two permits6. Achieving lower pollution Suppose the government decides to increase taxes on gasoline towards the goal of reducing noise pollution and traffic congestion to their optimal levels. Which of the following arguments best describes why corrective taxes, such as the gasoline tax, are unlike most other taxes? O Corrective taxes bring the allocation of resources closer to the social optimum and, thus, improve economic efficiency. O Other taxes get passed on from businesses to consumers, whereas corrective taxes do not. O Corrective taxes alter incentives, whereas other taxes typically do not. Other taxes are typically used to cover general spending, but funds from corrective taxes can be used only to alleviate pollution.7. Correcting for negative externalities - Taxes versus tradablepermits Nuclear facilities emit radioactive waste as a waste product. This generates a cost to society that is not paid for by the firm; therefore, pollution is a negative externality of electricity production. Suppose the U.S. government wants to correct this market failure by getting firms to internalize the cost of pollution. To do this, the government can charge firms for pollution rights (the right to emit a given quantity of radioactive waste). The following graph shows the daily demand for pollution rights. Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph. Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly.Graph Input Tool Daily Demand for Pollution Rights 90 81 Price CO (Dollars per ton) 72 Quantity 270 63 Demanded (Millions of tons) 54 45 PRICE (Dollars per ton) 36 27 Demand 18 O 0 30 60 90 120 150 180 210 240 270 300 QUANTITY (Millions of tons)Suppose the government has determined that the socially optimal quantity of radioactive waste is 120 million tons per day. One way governments can charge firms for pollution rights is by imposing a per-unit tax on emissions. A tax (or price in this case) of $ per ton of radioactive waste emitted will achieve the desired level of pollution. Now suppose the U.S. government does not know the demand curve for pollution and, therefore, cannot determine the optimal tax to achieve the desired level of pollution. Instead, it auctions off tradable pollution permits. Each permit entitles its owner to emit one ton of radioactive waste per day. To achieve the socially optimal quantity of pollution, the government auctions off 120 million pollution permits. Given this quantity of permits, the price for each permit in the market for pollution rights will be $ The previous analysis hinges on the government having good information regarding either the demand for pollution permits or the optimal level of pollution (or both). Given that the appropriate policy (tradable permits or corrective taxes) can depend on the available information and the policy goal, consider the following scenario.An environmental study conducted in a particular city suggests that if a chemical plant emits more than 50 million tons of chemicals each year, the water supply will become contaminated beyond the point where filtration techniques can make it safe for drinking. If this is all the information the government has, which solution to reduce pollution is appropriate? Check all that apply. O Corrective taxes O Tradable permits8. The effects of property rights on achieving efficiency Consider a river found in the city of Pittsburgh, and then answer the questions that follow. The city has a kayak rental whose visitors use the river for recreation. The city also has a chemical lab that dumps industrial waste into the river. This pollutes the river and makes it a less desirable vacation destination. That is, the chemical lab's waste decreases the kayak rental's economic profit.Suppose that the chemical lab could use a different production method that involves recycling water. This would reduce the pollution in the river to levels safe for recreation, and the kayak rental would no longer be affected. If the chemical lab uses the recycling method, then the chemical lab's economic profit is $1,000 per week, and the kayak rental's economic profit is $2,600 per week. If the chemical lab does not use the recycling method, then the chemical lab's economic profit is $1,700 per week, and the kayak rental's economic profit is $1,500 per week. These figures are summarized in the following table. Complete the following table by computing the total profit (the chemical lab's economic profit and the kayak rental's economic profit combined) with and without recycling. Profit Chemical Lab Kayak Rental Total Action (Dollars) (Dollars) (Dollars) No Recycling 1,700 1,500 Recycling 1,000 2,600 Total economic profit is highest when the recycling production method isWhen the chemical lab uses the recycling method, the kayak rental earns $2,600 - $1,500 = $1,100 more per week than it does with no recycling. Therefore, the kayak rental should be willing to pay up to $1,100 per week for the chemical lab to recycle water. However, the recycling method decreases the chemical lab's economic profit by $1,700 - $1,000 = $700 per week. Therefore, the chemical lab should be willing to use the recycling method if it is compensated with at least $700 per week. Suppose the kayak rental has the property rights to the river. That is, the kayak rental has the right to a clean (unpolluted) river. In this case, assuming the two firms can bargain at no cost, the chemical lab will the recycling method and will pay the kayak rental per week. Now, suppose the chemical lab has the property rights to the river, including the right to pollute it. In this case, assuming the two firms can bargain at no cost, the chemical lab will the recycling method, and the kayak rental will pay the chemical lab per week. The chemical lab will make the most economic profit when True or False: The chemical lab will use the recycling method only if the kayak rental has the property rights. O True O False$0 between $0 and $400 between $400 and $700 between $700 and $1,100$0 between $0 and $400 between $400 and $700 between $700 and $1,100it has property rights to pollute the river the kayak rental has property rights to a clean river9. Private solutions to correct for externalities Consider the following scenario: Suppose that a chicken farm uses a nearby stream to dispose of the wastes released by its chickens. These wastes flow downstream into a lake that has become thick with algae and polluted by the minerals in the waste matter. The local office of a nonprofit environmental organization collects enough donations to fund a campaign to stop the farm's pollution. Which of the following private solutions resolving the externality of pollution took place in this scenario? O Moral codes and social sanctions O CharitiesO Integration of different types of businesses through merger or acquisition O Contracts Keep in mind that sometimes private solutions to externalities are not achieved. For instance, this could occur when an excessive amount of time or money must be spent for parties to reach an agreement. This describes the problem oftransaction costs a breakdown in bargaining property held in common2. Individual demand and consumer surplus Consider the market for hyperbaric chambers. The market price of each hyperbaric chamber is $80,000, and each consumer demands no more than one hyperbaric chamber. Suppose that Van is the only consumer in the hyperbaric chamber market. Their willingness to pay for a hyperbaric chamber is $200,000. Based on Van's willingness to pay, the following graph shows his demand curve for hyperbaric chambers. Shade the area representing Van's consumer surplus using the green rectangle (triangle symbols).320 280 Van's Consumer Surplus 240 Van's Demand 200 PRICE (Thousands of dollars) 160 120 Market Price 80 40 0 0 1 2 3 5 QUANTITY (Hyperbaric chambers)Now, suppose another buyer, Amy, enters the market for hyperbaric chambers, and her willingness to pay is $120,000. Based on Amy's and Van's respective willingness to pay, plot the market demand curve on the following graph using the blue points (circle symbol). Next, shade Van's consumer surplus using the green rectangle (triangle symbols), and shade Amy's consumer surplus using the purple rectangle (diamond symbols). Note: Plot your points as a step function in the order in which you would like them connected. Line segments will connect the points automatically.320 O 280 Demand Curve 240 200 Van's Consumer Surplus 160 PRICE (Thousands of dollars) Amy's Consumer Surplus 120 Market Price 80 40 0 2 3 4 5 QUANTITY (Hyperbaric chambers)Suppose Carlos is willing to pay a total of $40,000 for a hyperbaric chamber. True or False: Keeping his maximum willingness to pay for a hyperbaric chamber in mind, Carlos will not buy the hyperbaric chamber because it would be worth less to him than its market price of $80,000. O True O False